Yahoo! Races For New Revenue As Net Ad Spending Tumbles

SANTA CLARA, Calif. — Give away a service for free on the Internet. Attract the biggest audience possible. Pay for it by selling advertising just like TV.

A few years ago, this plan seemed to herald the dawn of a New Economy. After the recent summer of dot-com carnage, it's been a disaster at many Internet companies.

Except at Yahoo!

The largest Internet portal has left its competitors in the dust and pulled in growing profits while giving away its basic services and paying the bills with ads. And yet, at the very moment when it appears Yahoo! Inc. has won, the Santa Clara company is being dogged by growing skepticism.

Critics say Yahoo! dependence on advertising has left it vulnerable as online companies slash their ad spending. While Yahoo! insists this will have little impact, the company is racing to create new services for which it can charge fees.

The debate over the future of Yahoo! is more than academic. Because the company is an Internet bellwether, the slightest hint of trouble casts a shadow over the whole online industry--and sometimes the overall stock market. Whether or not the company can prove its skeptics wrong may have implications for the whole industry and determine whether the free-service ideal remains a central part of the Web.

"I think anyone who's in the online media business is going to struggle in this business," said Patrick Keane, an analyst with research firm Jupiter Media Metrix. "And I don't think we're in the worst of it yet. Yahoo! is not insulated from this."

The doubts about Yahoo! show just how radically the mood surrounding the Internet has changed over the past year.

During the Internet's go-go days in 1999, companies boldly predicted there would be no profits in their foreseeable future, and analysts and investors gave them the benefit of the doubt.

By that point, Yahoo! was making a profit.

Initially, Yahoo! was one of the original search engines, along with companies like InfoSeek, Excite, Lycos and AltaVista. Yahoo! and its competitors started an arms race as they each added free services like e-mail, chat rooms, and free personal Web pages.

Over the past two years, Yahoo! broke away from the pack. As of August, it was the second most visited site on the Web, behind America Online and in front of Microsoft Corp.'s MSN--both of which are Internet service providers that charge monthly fees.

The next closest free Internet portal is Lycos, which draws only 63 percent as many unique visitors as Yahoo!.

Yahoo! has been profitable for at least 18 months. And over the past several weeks, some of its competitors, including AltaVista, Walt Disney's Go.com and NBC's Snap.com, have announced overhauls of their sites, in a tacit acknowledgment of Yahoo! dominance as a portal.

"The market doesn't need 15 Yahoos!," said John Corcoran, an analyst with CIBC World Markets. "These other lower-tier players are recognizing that."

And Yahoo! is laying a foundation for even more growth as it builds a new headquarters near Moffett Federal Airfield where the company--with 2,711 employees worldwide--plans to consolidate its Silicon Valley workforce.

For a while, Yahoo! seemed immune from the shakeout. But as more dot-coms began to struggle, analysts began to warn that Yahoo! would lose ad revenue. The stock sank from almost $250 at the beginning of this year to a closing price of $60 Friday. "We are entering a show-me market," said Susan Walker White, an analyst at JP Morgan Securities. "You say you're going to grow and do well. I'm going to reward you after you do it rather than before."

If you can think of something that you want on the Internet, you can probably find it on Yahoo! E-mail, chat, calendars, contact, news. That's the lure of the service as Yahoo! tries to keep users within its network as long as possible.

There's just one problem.

"We . . . have not yet determined an effective means of generating revenues directly from the provision of such services," Yahoo! said in its last earnings statement.

A Yahoo! spokesperson said he could not comment because it was in its "quiet period" before third quarter earnings Tuesday.

In the second quarter, Yahoo! had revenues of $270.1 million, up 110 percent from the same quarter last year. More than 90 percent came from advertising, compared with 30 percent for AOL.